"...Those guilty of illegal activities such as hoarding daily necessities, manipulating food supplies or product prices could be sentenced to jail terms of up to five years or fines of up to NT$3,000 (US$100). "

I wouldn't read too much in to the little anecdote I recounted about my local PM dealer offering 15 percent less than spot This was, after all, just for a bag of "junk" silver. In the meantime, where I live, one can divest oneself of non junk silver for excellent prices in private transaction for cash in less than 24 hours.

Desperado,That's the advantage of living in a consumer society, Goods are conveniently packaged in Hoarder friendly sizes. Backing up the truck to Costco is considered good citizenship. Throw a roll of duct tape on top and you pass as Prudence preparing for boogeyman terrorists.

When shortages appear one moves into the warehouse business, distribution center or some such cover. People will still need jobs. And goods. And of course, stay well capitalized.

"With the monetary system we have now, the careful saving of a lifetime can be wiped out in an eyeblink." ~ Larry Parks, Executive Director, FAME

"I believe that exchange rate volatility is a major threat to prosperity in the world today." ~ Dr. Robert A. Mundell, Nobel Laureate 1999"There's a sensible realization that small open economies, heavily dependent on trade and foreign capital, simply cannot live with the volatility that is inherent in freely floating exchange rates." ~ Dr. Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve

"A global economy requires a global currency." ~ Dr. Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve

"In the meantime, where I live, one can divest oneself of non junk silver for excellent prices in private transaction for cash in less than 24 hours."

Glad to hear that. If my scenario plays out todays prices will look cheap a few weeks from now. As the price of silver climbs perhaps you could test the market from time to time and let us know if the secondary market in your area remains liquid.

BTW I have read recommendations from silverbugs to load up on junk silver in order to avoid the premiums for higher purity forms of silver.

How does a hedge fund " borrow" via BB paper gold liabilities? Arent BB liabilities the hedge fund's asset? Are you talking about collateralized loans backed by gold? If so, the " hedge fund" would have to be long gold in the first place to get such a loan, or it would have to borrow at Libor to " buy" the BB loan it subsequently repledged. Not to mention you don't account for funding cost of margin.

Trust me, there is no arb. The arb you describe - a "positive carry free put" - is impossible. Does not exist. By definition, it would be arbed out. A 1 y put on gold at spot must be worth 5-10% notional.

In any case, your mechanics are wrong. You have to draw the boxes and arrows.

Can you quote FOFOA's text you are referring to, I can't place you comment in context.

FOFOA,

I trust you have seen http://gata.org/files/FedMemoG-10Gold&FXCommittee-4-29-1997.pdf

I'd like your views on this doc in the context of Another's and FOA's thoughts. Some key quotes:

"had created an environment where hedge funds and others found it attractive to play gold from the short side. Gold leasing was also a prominent piece of the market, whose growth central banks were very much a part of."

"gold does have a role as a war chest and in the international monetary system."

"the Governors would be discussing gold -- including whether central banks could come up with some coordinated approach to the gold market --- at their July meeting."

"The BIS did some leasing, but kept its participation moderate because it did not want to become 'too big' in that business and be seen as the liquidity provider of last resort."

"if some central banks were interested in building up gold reserves, they were likely to wait because the price was 'coming their way'."

"if there were an understanding among central bank re: gold sales, then leasing would also need to be part of the same understanding."

The hedge fund borrows gold the same way you borrow money from your credit card bank. The BB will lend gold or cash the same way your bank will lend you money. If you have good credit, your repayment contract is all the bank needs. It issues new liabilities to you and holds your repayment contract as the counterbalancing asset. Same with gold. Think: physical gold = physical cash... WRT... BB liabilities = electronic money.

The HF has to cash settle the gold loan based on spot price movement. It's just an OTC short position. Using COMEX to go long leaves HF flat price of gold. Any funding differential is due to margin funding costs to maintain long position, so there cannot be a net funding gain (same principle as interest rate parity).

It cannot be any other way, or else you have discovered a perpetual money machine.

You are confusing me. If the HF is short gold and hedged, and the gold price falls enough, it will make money on the loan in addition to whatever else it made in the interim. If gold rises, its hedge will come into play to minimize losses.

Of course it is cash settled, but the hedge reduces the risk of a rising POG. Why are you talking funding differential? It is simply a matter of exposure to gold versus dollars. If my numbers are off a little that's probably because I was using percentages separated by a week.

My point, which perhaps I didn't state clearly enough, was that it is a perpetual pressure builder, or viewed another way, a perpetual drain on the BB reserves that can only end in no reserves/infinite leverage factor. How much pressure can you push into a tank before it blows?

I don't understand where you think I was describing a perpetual money machine. Can you please explain?

You said HF (a) "borrow[s] $100,000,000 in paper gold BB liabilities and sell it for $100,000,000 cash" and that it also (b) "pay[s] the $5 million margin on a Feb. '12 contract for roughly two tonnes of gold" ie it buys Feb 2012 gold.

If the gold price falls, yes the HF will make money on (a) but it will also lose money on (b), which will offset the gain on (a), hence the HF is "flat [the] price of gold" as Texan said. The HF does not "have exposure to a huge windfall if the price of gold drops."

The only profit on this classic basis trade is the difference between spot and futures prices.

Just an observation that while the HF is hedged against price movements, they are not hedged against counterparty risk.

"The HF has to cash settle the gold loan based on spot price movement." Only if the BB required the HF to leave the cash from it sale of gold with the BB. If the BB was prepared to take counterparty exposure to the HF, then the HF has to settle the gold loan with unallocated ounces.

In loss of confidence in paper gold, the HF is not going to get physical ounces from the COMEX long position, just cash settle. Now the price of physical in such a situation may well be higher than COMEX contracts, but that doesn't matter to the HF because they don't have to deliver physical gold to the BB to repay their loan, only unallocated gold.

Now unallocated gold would also be trading at a discount to physical in such a situation. The question/risk for the HF is whether paper "unallocated" gold will trade higher than paper" COMEX gold, in which case the HF books a loss.

This may be possible as I can see a situation where COMEX warehouse are drained completely so no chance of getting physical (so big discount to physical spot price) but BB unallocated gold may be seen as "closer" to physical gold (ie more chance of getting physical from a BB).

I would guess that eventually all paper golds will trade at the same price, but I can also see a temporary period of uncertainty during the market's breakdown/transition/preference for physical where the various paper gold prices are different while the market scrambles to establish what is going on.

"But before you get too excited about silver backwardation, you might want to consider that it could simply be a fabrication bottleneck rather than a system-killing "monetary metal" explosion."

The fabrication bottleneck explanation only applies to non wholesale forms of metal. Wholesale forms (ie 1000oz silver bars) is the simplest way to make silver for a refiner and would not be subject to capacity limitations, only limited to the refinery's refining capacity.

The appearance of backwardation is interesting, but one should not get too excited by it in the early stages as it could easily revert back to contango.

The only backwardation that is interesting to me is one that is large (ie obvious and highly profitable arbitragable gap between spot and futures) and sustained over time.

Only when BBs and other large players will not take such highly profitable basis trades do we have a real indicator. We are not there yet.

I wrote, "I'll make a million for every percent (in excess of -5%)." You wrote, "The HF does not "have exposure to a huge windfall if the price of gold drops." I assume you are only talking about a movement within that 5% range.

If the POG drops more than 5% they'll just buy back the gold to return to the BB for less than $95,000,000, pocket the difference and write off the hedge. Am I wrong?

"If the BB was prepared to take counterparty exposure to the HF, then the HF has to settle the gold loan with unallocated ounces."... which can be purchased from the BB for cash.

"In loss of confidence in paper gold, the HF is not going to get physical ounces from the COMEX long position, just cash settle." Not sure if you're arguing with me or what here. The HF doesn't care about getting physical in any case. This was all paper I was writing about.

"but that doesn't matter to the HF because they don't have to deliver physical gold to the BB to repay their loan, only unallocated gold."... which can be purchased from the BB for cash.

To be honest, Bron, I can't tell if you are brainstorming with me here or arguing against my comment. Seems a little of both. But I question whether you understand the point I was driving at. That the BB "interest money making game" is a non-stop drain on its reserves as it must continually issue liabilities which can be redeemed by anyone possessing them. Just like a regular bank back in the gold standard days.

"Somewhere in this system all the remaining gold **IN SIZE** is busily being claimed. And at any moment (long before GLD is visibly drained) that process will be complete. Could it be two years from now? Sure. But I wouldn't bet on it. Could it be as soon as tomorrow. You bet!"

We have disagreed before on the closeness of such a transition. Physical "claiming" may be happening now, but I am not seeing any desperation - physical demand is good, but not indicating what you are talking about. Miners are still happy to swap physical gold loco Perth for unallocated gold loco London.

That is not to say there will not be some outside event that may shift perceptions and preferences for physical, but at the moment better to talk in years rather than months.

Price drops to $900. Yes the HF only has to pay $90,000,000 to buy unallocated gold to repay loan from BB, but has to cash settle Feb12 futures contract for a loss of 100,000oz x (1008-900) = $10,800,000. Cash flows summary:

My point about "Somewhere in this system all the remaining gold **IN SIZE** is busily being claimed" is that the "claiming" that matters cannot be visible because it is like a classic bank run in the pre-panic stage. It is a big secret the bank wants to keep under wraps while it tries to manage its remaining reserves. Once the reserves are at some critical stage for the BBs something (I don't know what) will happen which will stop all those other (smaller) transactions in their tracks because it will be realized that physical is worth much more.

Things will continue in a state of normalcy until "the giants" pull the plug. That's the point. Gold **IN SIZE** bidding for dollars is what matters. When that stops, gold in any size will also stop bidding for dollars, because it will suddenly be obvious that waiting a little while is the correct move.

In other words, I wouldn't (necessarily) expect you to see anything unusual at the Perth Mint up until that fateful moment, which is overdue IMO.

Of course the futures prices and LIBOR and lease rates used are not in alignment in time, so if the futures price was less than $1008 in our hypothetical example, the HF would actually make a profit even with a drop of %10 in the gold price, but no huge windfall.

I do agree that this "interest money making game" (or basis trade, carry trade, whatever you want to call it) does expose the BB as it increases their unallocated "base" which could be called for physical.

Only comment I have to that is whether most unallocated account contracts (ones with BBs) have any obligation by the BB to deliver physical at the unallocated owners request. I don't think they do, but will get back to you on that.

In normal markets yes a BB unallocated account owner can call for physical and does get it, but whether that will continue in the circumstances you mention is another thing. In that sense they are just like futures contracts where physical settlement is not guaranteed and cash settlement can be enforced.

If the HF buys Feb12 futures contract putting up $5m margin money in order to hedge the 100,000 ounces they owe back to the BB in Feb12, and gold drops 10% to $900/oz., why would the HF not just kiss the $5m goodbye and buy gold at $90m booking a $5m profit?

If you put up $5m then a 100% loss is $5m. Gain from a 10% drop is $10m. Net profit $5m. No?

"kiss the $5m goodbye" - can't do that, because COMEX will call more margin as the price drops below $950. If HF just kisses the $5m goodbye then they have closed out the futures and are now fully short, so if the price reaches $948 but then starts to move up beyond $950 the HF is screwed as they only have $95m which won't buy them 100,000oz if the price is above $950.

"wouldn't (necessarily) expect you to see anything unusual at the Perth Mint up until that fateful moment"

But consider that the Perth Mint refines 300t ($13 trillion worth) of gold a year. It is only 10% of new mine and scrap and probably a lesser fraction of overall physical turnover/trading (and I'm not talking paper turnover/trading here, only deals involving physical settlement), but do you think that BB activities could be hidden from us when we represent 10% of the new flow market?

However, maybe could be true as the non-new physical flow could mean we are much less than 10%, so I do keep that in mind.

My only counter to that is that when the non-new flow dries up, the BBs will be desperate to get hold of new gold flow, and we should see the result of that in the behaviour of miners and BBs and premiums on kilo gold bars.

By the time we see it, it could be so far advanced that it all happens very quickly from there.

You and I will just have to wait until then to resolve this question. Shall be interesting.

Re: Margin - Don't forget the HF manager is much smarter than the stupid gold bugs and he is neutral to negative on gold's future. If gold drops to $950 he is going to know why it is dropping because he is very smart. He will let that hedge go soon after, knowing the risk. I never said this was a fool-proof "perpetual money machine" as Texan did. My only point is that this game is being played with profits on both sides even in the face of rising POG which is putting a hidden pressure on the BB reserves. We have no idea where they stand, but the GLD drain might give us the idea that they are not in good shape.

FOFOA responds: "And my only counter to that is that the BB's main concern is maintaining confidence in the illusion that their reserves are sufficient. Not necessarily adding new reserves, not necessarily adding confidence, but maintaining existing confidence, which might be compromised by visible desperation in trying to add reserves. Especially since that tin foil guy Bron works at one of the big suppliers. ;)"

Bron writes: "By the time we see it, it could be so far advanced that it all happens very quickly from there.

"You and I will just have to wait until then to resolve this question. Shall be interesting."

FOFOA responds: "Now we're getting somewhere in this conversation that has a distinct ring to it."

Hello Costata,the reason why I address you, is because I know you will answer my question.assuming that central banks start looking for silver in order to faster liquidate their dollar reserves. I wont discuss here why they will be prompted to do so, but lets assume that tomorrow, feb 21, central bank of china makes that announcment, and as a result others banks follow suit? wouldnt FOFOA'S argument lose ground in favor of silver? wouldnt you buy silver to protect your wealth ?

See, with silver the banks would have to find all new storage and accting for it et al. Instead tungsten would be the QE of the physical world. Banks would mix a bit of tungsten into every batch, making tungsten worth its (90%) weight in gold, enslavedGold, gold, that is.

Bron,I am busy dishoarding AG, Your products are very popular on ebay. A big hit in Germany - they paid huge premiums. A couple of your 5 oz painted dogs were bought by a Dog Show, as a first prize award. They are smiling today.

I really like the Pamp 5 gr pendants, (Au) Do you have anything that competes with that?

Especially inlight of the ever changing Middle East situation, additional information on Moody's Analytics' Sovereign research is available at: http://www.moodysanalytics.com/Products-and-Solutions/Credit-Research-Risk-Measurement/Credit-Research/Moodys-Sovereign-Research.aspx

Total Pageviews

Disclaimer

The above is presented for educational and/or entertainment purposes only. Under no circumstances should it be mistaken for professional investment advice, nor is it at all intended to be taken as such. The commentary and other contents simply reflect the opinion of the author alone on the current and future status of the markets and various economies. It is subject to error and change without notice. The presence of a link to a website does not indicate approval or endorsement of that web site or any services, products, or opinions that may be offered by them.